Seth Klarman has continuously added to his stake in the satellite company ViaSat (VSAT) over the years. It ranks as one of his largest investments and like many of his investments, difficult to discern the value of. Unlike his investment in Vivendi (VIVHY) which requires but a glance at the financials to see its attractiveness, ViaSat is one that is priced at a steep premium to earnings. ViaSat is also priced at a premium to book value. Its assets, which include satellites in orbit, are hardly ones that will fetch much liquidation value, particularly as technology rapidly changes in the sector.

But what ViaSat does appear to have is an indomitable position in delivering high-speed Internet access to obscure regions in the U.S. and the world. The company recently launched a satellite with throughput capacity of 140 gigabytes/second. It will offer 12 megabits per second of broadband to customers making it the high speed option for those living outside the reach of high speed cable or fiber optic lines. ViaSat expects to service some 1 million customers with this new satellite. Hughesnet recently launched a satellite capable of 15 mb/s, but these two companies are largely the only game in town in delivering high-speed satellite broadband to rural locations and that is evident in pricing.

ViaSat is pricing its new high-speed Internet access from $50 per month for a 10 gigabyte data plan to $130 per month for 25 gigabytes per month. Keep in mind that with few options in rural areas this pricing is not out of line. There are disadvantages to the service, however. Because of the satellite’s high orbit, certain services such as VOIP and gaming would suffer as there would be a gap during transmission. But overall download and upload speeds will be substantially improved and it could open up new markets.

ViaSat has established joint ventures with JetBlue (JBLU) in delivering broadband on airplanes and recently with DirecTV (DTV) on bundling satellite TV and broadband together. ViaSat is also active in the government sector and provides communication resources for the U.S. military. However, that portion of its overall revenue has declined from about 30% to 20% in the past couple years as commercial satellite broadband has taken off.

ViaSat is hailed as one of the leading small cap companies with great potential, but that is really all it is. A deal it is not. Looking at the financials, ViaSat earned $0.17 per share in its most recent 10-K (ending March 2012) and $0.84 per share its previous year giving it a price to earnings of 40 for that year’s earnings. Earnings were muted because of various one-off costs relating to acquisitions customer subscriber growth. Revenues have grown from $680 million to $860 million over the past three years and revenues should continue to grow with haste as the company rolls out its high-speed offering.

In its recent analyst day the company made an interesting observation of the high return on capital of “satellite TV” companies (exhibit 3). As the chart notes, DirecTV and Dish had return on invested capital in excess of 40%. The problem with this claim is that Dish is not a pure satellite company as this satellite analyst notes. Dish has instead leveraged its network and is piggybacking off satellite companies likely giving it an edge on return on capital. DirecTV has also seen its asset turnover increase over the decade though the company does appear to be very active managing its satellites.

ViaSat probably won’t be making high returns on capital any time soon as the presentation seems to imply. The company should be able to grow earnings per share substantially and does appear to have a moat around this business, but it will be years before it is producing enough earnings to rationalize a 40% return on capital. Current capital (debt plus equity) stands at around $1.4 billion while the company’s most profitable year was 2009 when it made $39 million.

Intuitively, a capital-intensive business involved in developing and launching satellites into space (as ViaSat recently launched a $400 million one last year) does not seem like it will lend itself to high returns on capital. The returns will come when and if the company can be successful in creating a deep network just as DirecTV has done.

Perhaps this is what Klarman is hoping for, but it does not seem to fit the mold of most value investing frameworks. I’ve found the website Satellite Today to be enlightening on the dynamics of the satellite industry, specifically the articles by this columnist. Some satellite analysts believe there will be a shakeout in the satellite industry with companies such as ViaSat and Hughesnet rounding out the top. Developments like this would certainly play out in the favor of ViaSat. Still these satellite companies will be competing against terrestrial broadband such as fiber optic lines, 4G, LTE and other mediums for Internet transmission. ViaSat will have to bring its prices down and data throughput up in order to maintain competiveness in the long run as the terrestrial competitors encroach.

A monopoly (or duopoly) on high-speed Internet in rural America may not return a high return on capital immediately. Nevertheless, it should return a sustainably high profit margin and this may justify Klarman’s conviction.

I'm long, but its a very tiny stake (around 1% of my portfolio). I admit it is to coat tail, but from everything I've read about it, its a company I don't mind paying a high p/e ratio for. Klarman has a number of businesses in his portfolio that have high p/e ratios as well as pharmaceuticals which I find incomprehensible. But this one is not terribly complex to understand.

I'm going to keep studying the company and may add to the stake if I can see more value in it, but I'm considering the $1000 I have in it as purely speculative.

I know Baupost does prefer to invest in debt securities, but the fund is indeed invested in common shares of ViaSat. If you look at the major holders of ViaSat in yahoo finance Baupost is listed with a 24% share of the company. See its SEC filing also: [sec.gov]

What has Klarman shorted (besides T-bonds) in the past? I wasn't familiar with any short positions in stocks

I agree with joliveras, dont try to reverse engineer what Klarman and Baupost see in this, these guys are very sophisticated. In addition, your analysis is very standard based for Klarman, focusing a lot on economics and trends.

Klarman is usually looking for motivated or forced sellers and specially for a margin of safety. Whats Viasat margin of safety? I would address those questions first.

Why would you (or anyone else) not coat-tail Ted Weschler and Lou Simpson into DirecTV? The business is easier to understand, has an enviable position in North America, a fast growth business in Latin America, has the high ROIC that you mentioned, and is buying back over $5B of stock this year. The buyback yield is at approximately 16% and the EBIT yield is about 15% at today's price levels. And let me rephrase the original question: in comparing Viasat and DTV, on the surface, DTV is the no-brainer.

You guys have good points and I agree that trying to understand Klarman may be in vain, but that's no reason not to try. I would revise my statement that ViaSat is a conviction of Klarman's, instead it's only about 2% of his entire $24 billion portfolio even though its more than 12% of his total US equity portfolio.

In regards to Weschler and Simpson they too are great investors, but do they necessarily match up to Klarman? I value their views also, but if they're logging less than 20% annual returns then I'm less interested. Quite frankly I'm interested in the best ideas from the best investors - at comparable or better prices - and that's my margin of safety.

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